Cancellation of Debt as Income

Here’s something that may surprise you if you’re trying to get a creditor to forgive or discharge a debt that you owe them, particularly if it’s a mortgage lender or a company that has extended you some form of credit—if the debt is discharged, you may be required to claim the amount forgiven as income on your next personal tax return! But wait a minute, you might say, I never received a nickel. Unfortunately, that doesn’t prevent the IRS from considering it to be income.

As defined by the United States Supreme Court, income is anything that offers or provides “accession to wealth.” When a creditor discharges a debt that you legally owe, you have “access” to funds that were not available before—the money that you would have paid your creditor. You can use that money for any legal purpose, so it has all the earmarks of income. It’s important to understand, though, that not every cancellation of debt will cause you to recognize income—the amount forgiven must be more than $600.

There are also other situations where the discharge of a debt will not constitute income:

• If the discharged debt is a “qualified farm indebtedness,” no income will be recognized
• Any discharge that’s part of a Chapter 11 bankruptcy petition will not be construed as income
• There’s no income if, at the time of the discharge, the debtor was insolvent
• The debts of a qualified real property business may also be discharged without the recognition of income

Contact Heath, TX Bankruptcy Attorney Carrie Weir

I offer a free initial consultation to all potential bankruptcy clients. Contact my office by e-mail or call me at 972-772-3083 for a private meeting. With offices in Rockwall, Texas, I represent clients in Heath, Greenville, Lavon, Wylie, Mesquite and Rowlett.